Negative Externalities

Where the Free Market Needs Help

EXTERNALITIES

• An externality is the uncompensated impact of one person’s actions on another person

Efficiency requires:

• All costs of production must be counted by producers

• If pollution is “not counted” => society bears the costs of production

This is not efficient

Negative Externalities

– Automobile exhaust– Cigarette smoking

– Barking dogs (loud pets)

– Loud stereos in an apartment building

– Noisy Students– Neighbor’s poorly maintained

property

– Pollution

Positive Externalities

– Restored historic buildings– Research into new technologies– Neighbor’s well maintained property

Youtube video—cool examples

MARKET INEFFICIENCY

• Negative externalities lead markets to overproduce

Quantity ofAluminum

0

Price ofAluminum

EquilibriumEquilibrium

Demand(marginal benefit)

Demand(marginal benefit)

Supply(marginal cost)

Supply(marginal cost)

QMARKETQMARKET

Market price should be here

Quantity demanded/supplied at the true price should be here

S2

Specific Examples:

Before

After Regulation/Clean Up Efforts

Lake Erie

Acid Rain

Global Warming

Solutions to Pollution

Increase Government Regulation

a) Tax the pollutant

b) Fine corporations/individuals who pollute

c) Provide incentive to not pollute

oil carbon, etc.

Creating an Incentive to Not Pollute: Cap & Trade System

• Gov’t can create a system of trading pollution credits

[Read Article if time]

Questions to consider:

1.Who is in charge of pollution standards?

2. Should countries all have the same pollution/

environmental standards?

Global Pollution Standards